Headline / October 2019

Small Bumps in the Road

By Dion Bisara

Indeed, Indonesians’ fixation with cigarettes has seen the family-controlled company become one of the country’s most valuable.

Even the increasing use of electronic cigarettes has so far been a mere blip for Gudang Garam, which sees little reason to even consider making an incursion.

Recent findings by medical researchers in the United States and Britain linking the use of e-cigarettes to respiratory illness only vindicate the company’s view.

“E-cigarettes and cigarettes are not 100 percent the same. The former commands a price we cannot consider cheap,” said Heru Budiman, a director at Gudang Garam. “We’ll see if we will enter the industry, but for now, we are only watching from the sideline.”

The company has reason to remain confident. It controls about a quarter of Indonesia’s $25 billion tobacco industry, according to German online statistics portal Statista. Gudang Garam is second only to rival HM Sampoerna, which controls about a third of the Indonesian cigarette market – one of the world’s largest.

Gudang Garam has production facilities in Kediri and Gempol, both in East Java.

Indonesia is home to 64.5 million active smokers, among them 469,000 children between the ages of 10 and 14 who smoke daily, according to data from The Tobacco Atlas, a global tobacco control watchdog. Despite government efforts to curb tobacco use through stricter rules on smoke-free zones, limits on advertisements and higher excise duty, the country still has the third-largest number of smokers in the world, after Russia and China.

Indonesia does not impose any penalties on sales of cigarettes to minors, which is reflected in Gudang Garam’s financial performance. The company’s sales have increased consistently over the past decade to a projected record of more than Rp 100 trillion ($7 billion) this year from Rp 31 trillion in 2009, according to analysts.

However, the company’s net income did not rise every year during this period, as it absorbed shocks from government policies. Still, securities company Mirae Asset Sekuritas Indonesia has projected that Gudang Garam is on track to book net income of Rp 9.8 trillion this year, almost triple that of a decade ago.

“Why do you think we can keep growing despite the industry slowing? This is because, primarily, the loyalty of our customers. Second, we maintain our quality, and third, our product is easily available,” Heru said.

“Also, we differentiate ourselves by selling products at more affordable prices,” he said, referring to the company’s strategy of introducing cheaper cigarettes to prevent customers from switching to other brands each time the government increases excise.

To investors, Gudang Garam is a darling as it is quite generous with its dividends. Yet this has not affected its ability to accumulate capital, thanks to the company’s hefty profit margin – Gudang Garam’s return on equity has hovered at between 16 percent and 20 percent over the past decade, among the highest in the country.

Gudang Garam and other cigarette companies will face a steep 23 percent increase in excise duty and a 35 percent increase in the minimum retail price of cigarettes next year.

Still, as the experiences of the past decade have shown, excise duty did little to stem people’s desire to inhale poisonous substances from burning sticks. But their purchasing power does play a role.

“There’ll indeed be an increase in our costs due to the excise duty hike and it will erode our profit. We must pass it on to customers; itwill be done in stages, depending on how people’s purchasing power change next year,” Heru said.

The government has set an economic growth target of 5.3 percent next year, with the rate of inflation at 3.5 percent. But many institutions, including the World Bank, have warned that there is a fair chance Southeast Asia’s largest economy may grow at less than 5 percent in 2020, due to the impact of a potential global trade war and capital flight.

“If there is no drastic improvement in purchasing power, we will be realistic and not raise our prices arbitrarily,” Heru said.